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CORPORATE GOVERNANCE IN BANKING

SECTOR IN INDIA
Banks form a crucial link in a countrys financial system and their well-being is imperative for the
economy.
The significant transformation of the banking industry in India is clearly evident from the changes that
have occurred in the financial markets, institutions and products. While deregulation has opened up
new vistas for banks to augment revenues, it has entailed greater competition and consequently
greater risks. Cross-border flows and the entry of new products have significantly influenced the
domestic banking sector, forcing banks to adjust the product mix, as also to effect rapid changes in their
processes and operations in order to remain competitive in the globalized environment.
In such scenario, implementation of good corporate governance practices in banks can ensure them to
cope with the changing environment. Todays corporate governance means to do everything better and
provides for risk assessment, risk cover, early warning systems against failure as well as prompt
corrective action.

Introduction to corporate governance


Corporate governance is "the system by which companies are directed and controlled". It involves
regulatory and market mechanisms, and the roles and relationships between a companys
management, its board, its shareholders and other stakeholders, and the goals for which the
corporation is governed.
In contemporary business corporations, the main external stakeholder groups are shareholders, debtholders, trade creditors, suppliers, customers and communities affected by the corporation's
activities. Internal stakeholders are the board of directors, executives, and other employees.

Much of the contemporary interest in corporate governance is concerned with mitigation of the
conflicts of interests between stakeholders. Ways of mitigating or preventing these conflicts of
interests include the processes, customs, policies, laws, and institutions which have an impact on the
way a company is controlled. An important theme of corporate governance is the nature and extent of
accountability of people in the business.

Need of Corporate Governance in Banking


In the Indian context, the need for corporate governance has been highlighted because of the scams
occurring frequently since the emergence of the concept of liberalization from 1991 such as the Harshad
Mehta Scam, Ketan Parikh Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam and so on.
In the Indian corporate scene, there is a need to induct global standards so that at least while the scope
for scams may still exist, it can be at least reduced to the minimum. From the beginning of 1980s,
situations have changed in India. There have been wide-ranging changes has taken place in both the
laws and the regulations in the field of corporate law and the capital market. As a result of several scams
in India, a need has arisen to bring reforms, in response to that reforms began in 1991 in India.
The most important event in the field of investor protection in India was the establishment of
Securities and Exchange Board of India (SEBI) in 1992. Corporate governance is a multi-faceted subject.
An important theme of corporate governance deals with issues of accountability and fiduciary duty,
essentially advocating the implementation of policies and mechanisms to ensure good behavior and
protect shareholders.
Another key focus is the economic efficiency view, through which the corporate governance system
should aim to optimize economic results, with a strong emphasis on shareholders welfare. In India the
concept of corporate governance is gaining importance because of two reasons.
After liberalization, there has been institutionalization of financial markets, FIIs and FDIs became
dominant players in the stock markets. The market began to discriminate between wealth
destroyers. Corporate governance is a critical by product of market discipline.
Another factor is the increased role being played by the private sector. Companies are realizing
that investors love to stay with those corporate that create values for their investors. This is only
possible by adopting fair, honest and transparent corporate practices.

History of Corporate Governance in India


There have been several major corporate governance initiatives launched in India since the mid-1990s.
The first was by the Confederation of Indian Industry (CII), Indias largest industry and business
association, which came up with the first voluntary code of corporate governance in 1998. The second
was by the SEBI, now enshrined as Clause 49 of the listing agreement. The third was the Naresh Chandra
Committee, which submitted its report in 2002. The fourth was again by SEBI the Narayana Murthy
Committee, which also submitted its report in 2002. Based on some of the recommendation of this

committee, SEBI revised Clause 49 of the listing agreement in August 2003.Subsequently, SEBI
withdrew the revised Clause 49 in December 2003, and currently, the original Clause 49 is in force.

A. The CII Code: CII set up a committee to examine corporate governance issues, and recommend
a voluntary code of best practices. The committee was driven by the conviction that good
corporate governance was essential for Indian companies to access domestic as well as global
capital at competitive rates. The first draft of the code was prepared by April 1997, and the final
document (Desirable Corporate Governance: A Code), was publicly released in April 1998. The
code was voluntary, contained detailed provisions, and focused on listed companies.
B. Desirable Disclosure: Listed companies should give data on high and low monthly averages of
share prices in a major stock exchange where the company is listed; greater detail on business
segments, up to 10% of turnover, giving share in sales revenue, review of operations, analysis of
markets and future prospects. Major Indian stock exchanges should gradually insist upon a
corporate governance compliance certificate, signed by the CEO and the CFO. If any company
goes to more than one credit rating agency, then it must divulge in the prospectus and issue
document the rating of all the agencies that did such an exercise. These must be given in a
tabular format that shows where the company stands relative to higher and lower ranking.
C. Kumar Mangalam Birla committee report and Clause 49: While the CII code was well-received
and some progressive companies adopted it, it was felt that under Indian conditions a statutory
rather than a voluntary code would be more purposeful, and meaningful. Consequently, the
second major corporate governance initiative in the country was undertaken by SEBI. In early
1999, it set up a committee under Kumar Mangalam Birla to promote and raise the standards of
good corporate governance. In early 2000, the SEBI had accepted and ratified key
recommendations of this committee, and these were incorporated into Clause 49 of the Listing
Agreement of the Stock Exchanges.
D. The constitutions of Committee: The committee has identified the three key constituents of
corporate governance as the shareholders, the Board of Directors and the Management. Along
with this the committee has identified major 3 aspects namely accountability, transparency and
equality of treatment for all shareholders. Crucial to good corporate governance are the
existence and enforceability of regulations relating to insider information and insider trading.
These matters are currently being examined over here. The committee had received good
comments from almost all expertsinstitutions, chamber of commerce Adrian Cadbury
Cadbury Committee etc.
E. Corporate Governance Objectives: Corporate Governance has several claimants shareholders,
suppliers, customers, creditors, the bankers, employees of company and society. The committee
for SEBI keeping view has prepared primarily the interests of a particular classes of stakeholders

namely the shareholders this report on corporate governance. It means enhancement of


shareholder value keeping in view the interests of the other stack holders. Committee has
recommended C.G. as companys principles rather than just act. The company should treat
corporate governance as way of life rather than code.
F. Naresh Chandra Committee Report: The Naresh Chandra committee was appointed in August
2002 by the Department of Company Affairs (DCA) under the Ministry of Finance and Company
Affairs to examine various corporate governance issues. The Committee submitted its report in
December 2002. It made recommendations in two key aspects of Corporate Governance:
financial and non-financial disclosures: and independent auditing and board oversight of
management.
G. Narayan Murthy Committee report on Corporate Governance: The fourth initiative on
corporate governance in India is in the form of the recommendations of the Narayana Murthy
committee. The committee was set up by SEBI, under the chairmanship of Mr. N. R. Narayana
Murthy, to review Clause 49, and suggest measures to improve corporate governance
standards. Some of the major recommendations of the committee primarily related to audit
committees, audit reports, independent directors, related party transactions, risk management,
directorships and director compensation, codes of conduct and financial disclosures.
H. Confederation of Indian Industry (CII) Taskforce on Corporate Governance: History tells us that
even the best standards cannot prevent instances of major corporate misconduct. This has been
true in the US - Enron, WorldCom, Tyco and, more recently gross miss-selling of collateralized
debt obligations; in the UK; in France; in Germany; in Italy; in Japan; in South Korea; and many
other OECD nations. The Satyam-Maytas Infra-Maytas Properties scandal that has rocked India
since 16th December 2008 is another example of a massive fraud.
I.

Corporate Governance voluntary guidelines 2009: More recently, in December 2009, the
Ministry of Corporate Affairs (MCA) published a new set of Corporate Governance Voluntary
Guidelines 2009, designed to encourage companies to adopt better practices in the running of
boards and board committees, the appointment and rotation of external auditors, and creating
a whistle blowing mechanism. The guidelines are divided into the following six parts: i) Board of
Directors, iii) Audit Committee of the Board iv) Auditors v) Secretarial Audit vi) Institution of
mechanism for Whistle Blowing

How is Corporate Governance of Banks Different?


Banks are different from other corporates in important respects, and that makes corporate governance
of banks not only different but also more critical. Banks lubricate the wheels of the real economy, are
the conduits of monetary policy transmission and constitute the economys payment and settlement
system. By the very nature of their business, banks are highly leveraged. They accept large amounts of
uncollateralized public funds as deposits in a fiduciary capacity and further leverage those funds through
credit creation. The presence of a large and dispersed base of depositors in the stakeholders group
sets banks apart from other corporates.

Evolution of Corporate Governance of Banks in India


In the pre-reform era, there were very few regulatory guidelines covering corporate governance of
banks. This was reflective of the dominance of public sector banks and relatively few private banks. That
scenario changed after the reforms in 1991 when public sector banks saw a dilution of government
shareholding and a larger number of private sector banks came on the scene.
First: The competition brought in by the entry of new private sector banks and their growing market
share forced banks across board to pay greater attention to customer service. As customers were now
able to vote with their feet, the quality of customer service became an important variable in
protecting, and then increasing, market share.

Second: Post-reform, banking regulation shifted from being prescriptive to being prudential. This
implied a shift in balance away from regulation and towards corporate governance. Banks now had
greater freedom and flexibility to draw up their own business plans and implementation strategies
consistent with their comparative advantage. The boards of banks had to assume the primary
responsibility for overseeing this. This required directors to be more knowledgeable and aware and also
exercise informed judgment on the various strategy and policy choices.

Third: Two reform measures pertaining to public sector banks - entry of institutional and retail
shareholders and listing on stock exchanges - brought about marked changes in their corporate
governance standards. Directors representing private shareholders brought new perspectives to board
deliberations, and the interests of private shareholders began to have an impact on strategic decisions.
On top of this, the listing requirements of SEBI enhanced the standards of disclosure and transparency.
Corporate Governance has become very important for banks to perform and remain in competition in
this era of liberalization and globalization.

Fourth: To enable them to face the growing competition, public sector banks were accorded larger
autonomy. They could now decide on virtually the entire gamut of human resources issues, and subject
to prevailing regulation, were free to undertake acquisition of businesses, close or merge unviable
branches, open overseas offices, set up subsidiaries, take up new lines of business or exit existing ones,
all without any need for prior approval from the Government. All this meant that greater autonomy to
the boards of public sector banks came with bigger responsibility.

Fifth: A series of structural reforms raised the profile and importance of corporate governance in banks.
The structural reform measures included mandating a higher proportion of independent directors on
the boards; inducting board members with diverse sets of skills and expertise; and setting up of board
committees for key functions like risk management, compensation, investor grievances redressal and
nomination of directors. Structural reforms were furthered by the implementation of the Ganguly
Committee recommendations relating to the role and responsibilities of the boards of directors, training
facilities for directors, and most importantly, application of fit and proper norms for directors.

Corporate Governance in Banks

In banking parlance, the Corporate Governance refers to conducting the affairs of a banking
organization in such a manner that gives a fair deal to all the stake holders i.e. shareholders, bank
customers, regulatory authority, society at large, employees etc.

As per Basel committee Report 1999,

Banks have to display the exemplary of corporate governance practices in their financial
performance, transparency in the balance sheets and compliance with other norms laid down by
section 49 of corporate governance rules.
Most importantly, their annual report should disclose accounting ratios, relating to operating
profit, return on assets, business per employee, NPAs, maturity profile of loans, advances,
investments, borrowings and deposits.
Similarly the audit reports of bank should highlight those disclosures which are in line with
corporate governance rules. Hence, auditors should have the complete know how about all the
features of the latest guidelines given by Reserve Bank of India (RBI) and ensure that the
financial statements are made in a fraud free manner and should mirror the implementation of
corporate governance.

Apart from auditors seriousness to bring those requirements appropriately in audit report,
there should be adequate internal control systems in the operational activities of banks.
It is very much essential for banks to devote adequate attention on internal control system so
as to maximize their returns on each unit of capital inducted through an effective funds
management strategy and mechanism.

From the perspective of banking industry, corporate governance also includes in its ambit the manner in
which their Board of Directors governs the business and affairs of individual institutions and their
functional relationship with senior management. This is determined by how banks:

set corporate objectives (including generating economic returns to owners);


run the day-to-day operations of the business and;
consider the interests of recognized stakeholders i.e., employees, customers, suppliers,
supervisors, governments and the community and
line up corporate activities and behaviors with the expectation that banks will operate in a safe
and sound manner, and in compliance with applicable laws and regulations; and of course
protect the interests of depositors, which is supreme.

There are four important forms of oversight that should be included in the organizational structure of
any bank in order to ensure the appropriate checks and balances:
(1)
(2)
(3)
(4)

Oversight by the board of directors or supervisory board;


Oversight by individuals not involved in the day-to-day running of the various business areas;
Direct line supervision of different business areas; and
Independent risk management and audit functions. In addition to these, it is important that the
key personnel are fit and proper for their jobs

Corporate Governance in Public Sector Banks

Basel Committee has underscored the need for the banks to establish the strategies and to
become accountable for executing as well as implementing them.
The existing legal institutional framework of public sector banks is not aligned with principles of
good corporate governance.
The bureaucratic hassles, red tapes and demotivated work culture add further fuel to the fire.
So far banks have been burdened with social responsibility and compelled to tow the line of
thinking dictated by the political party in power, healthy banking policies will not be able to
become the top priority.
Monopoly of PSB in banking business had protected them from competition and bank
Managements have thereby became complacent.
Corporate Governance in PSBs is important, not only because PSBs happen to dominate the
banking industry, but also because, they are unlikely to exit from banking business though they
may get transformed. To the extent there is public ownership of PSBs, the multiple objectives of

the Government as owner and the complex principal-agent relationships cannot be wished
away. PSBs cannot be expected to blindly mimic private corporate banks in governance though
general principles are equally valid.
Complications arise when there is a widespread feeling of uncertainty of the ownership and
public ownership is treated as a transitional phenomenon. The anticipation or threat of change
in ownership has also some impact on governance, since expected change is not merely of
owner but the very nature of owner. Mixed ownership where government has controlling
interest is an institutional structure that poses issues of significant difference between one set
of owners who look for commercial return and another who seeks something more and
different, to justify ownership.
Furthermore, the expectations, the reputation risks and the implied even if not exercised
authority in respect of the part-ownership of government in the governance of such PSBs should
be recognized. In brief, the issue of corporate governance in PSBs is important and also complex.

From the banking industry perspective, the attributes of corporate governance provide guidelines to
the directors and the top level managers to govern the business of banks. These guidelines relate to

how banks establish corporate aims,


carry out their daily activities, and
take into account the interest of stakeholders and
making sure that the corporate activities are in tune with the public expectations that banks will
function in an ethical and legal manner thereby protecting the interest of its depositors (Basel
Committee, 1999).

All these broad issues relating to governance apply to other companies also, but they assume more
significance for banks because they deal with public deposits directly. Banks' philosophy for Corporate
Governance should lay emphasis on the cardinal values of 'fairness', 'transparency' and
'accountability', as enunciated by World Bank, for performance at all levels, thereby, enhancing the
shareholders' value and protecting the interest of the stakeholders.

Corporate Governance in Private Sector Banks

Private sector banks have entered niche areas, listed their scrip and being market driven they have been
more transparent in their functioning. They have also been more tech savvy, growth oriented and have
less of NPAs.
Private sector banks has to conform with standard of good banking practices such as

Ensuring a fair and transparent relationship between the customer and bank
Instituting comprehensive risk management system and its adequate disclosure

Proactively handling the customer complaints and evolving scheme of redressal for grievances.
Building systems and processes to ensure compliance with the statutes concerning banking.

Recent Steps Taken by Banks in India for Corporate Governance


(a) Induction of non executive members on the Boards
(b) Constitution of various Committees like Management Committee, Audit Committee, Investors
Grievances Committee, ALM Committee etc.
(c) Gradual implementation of prudential norms as prescribed by RBI,
(d) Introduction of Citizens Charter in Banks
(e) Implementation of Know Your Customer concept, The primary responsibility for good governance
lies with the Board of Directors and the senior management of the Bank

Conclusion
The following aspects require special mention while judging the standard of corporate governance in a
banking institution:
(a)
(b)
(c)
(d)
(e)

Constitution of the Board of directors:


Transparency
Policy formulation
Internal controls
Committees of the Board

By fixing prudential standards, the regulators can improve the corporate governance and RBI has
already taken a no. of steps during the recent years to enhance the usefulness of good corporate
governance. However, there is lot, which the banks themselves have to do, since adherence to
prudential norms is the minimum level of compliance and banks have to achieve higher standards for
good governance. The success of corporate governance lies in minimizing the regulatory norms and
adoption of voluntary codes.

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